Luxembourg has been forced to step back and take stock of the way things are done. In doing so it found that actually, the Grand Duchy is still a reliable and reputable financial centre – and asset servicers on location are more than happy to talk about its achievements. (part 2) Roundtable_2
Régis Veillet (head of sales & client relationship, SGSS Luxembourg), Martin Bock (head of product management, RBC Dexia Luxembourg)
Fabrice Godefroid (head of securities & funds services, Citi Global Transactions Services), Tim Gandy (global head of fiduciary & compliance services, JP Morgan WSS)
Josée Denis (VP Emea sales & business development, BNY Mellon Asset )Servicing
Funds Europe: Would the approach be on an asset-class-by-asset-class basis? Gandy: Exactly. Veillet: We have a big fund of funds business so we are dealing with multiple transfer agents. It’s a very simple example but it’s exactly the same thing. If a client invests in a fund for which the transfer agent is RBC Dexia, should I be held liable for the fact that RBC Dexia is performing or not? I’m just taking your firm as an example, Martin. Godefroid: I have slightly different views. We contributed to the Alfi best practice document, which we fully support as a member of the industry, but to me this was just creating a sense of urgency to have a documented approach.
So now the question is, ‘Do you need regulation to be changed to enhance the diligence or control requirements of the custodians?’ The way we see it is that there is more to come in terms of regulation.
For us, there are two sorts of providers. One is the banks and custodians who don’t own their network and the other is those that do. Those custodian banks with their own network are more able to adapt to new or pending regulation, thus posing a lower counterparty risk, while those without their own network will need to price their service differently due to their different risk exposure.
Global custodians who own their networks probably have controls in place that are over and above what the regulation is asking for. However, the regulatory changes will capture the gap in the coming months/years and force those without their own network to change their business models in order to remain competitive.
Denis: Most of us are global custodians around this table so I would say it’s the smaller guy, those niche markets that do not have the regulatory support or the framework to be able to ascertain and fully acknowledge the underlying responsibilities that they actually have and should have.
Funds Europe: Almost everything that we’ve spoken about refers to the Madoff scandal. So how about we speak specifically about it. A custodian I spoke to said, ‘We would have never allowed Madoff to be sub-custodian to the extent that he was’. Would you say the same goes for your organisations? Bock: One hundred per cent. It’s surprising how anybody appointed Madoff given all the due diligence, the ongoing monitoring and controls, the risk assessment that is involved. How does it happen? Denis: How did it happen? That’s the point. Bock: It is a shame that the collective blindness Madoff managed to pull off was associated with Luxembourg. I wouldn’t associate this specific issue to Luxembourg, but leaving the technicalities aside, what Luxembourg should probably avoid is this eternal niche offshore image, where nothing seems to really be regulated, which doesn’t correspond to reality. Madoff is much more a wake-up call to polish the image of Luxembourg  and not give the ammunition to its critics. Denis: Luxembourg does have a few envious neighbours. Bock: Of course, that’s exactly it. This is an excellent opportunity for Luxembourg to polish its image and to be considered more as a solution centre rather than just an offshore location.
Denis: Madoff was ultimately a US scandal that affected related parties worldwide. Obviously Luxembourg had some assets that were held here but it’s minimal compared to the total assets under management of the industry as a whole. Having said that though, by having the spotlight on Luxembourg under such a major scandal, it did open the door to our envious neighbours who now thought they had a reason to point the finger.
Luxembourg industry participants should be proud at the quick responsiveness of all industry players involved. All our companies had a global/local Madoff taskforce in place within days with weekly updates across all participants and trading counterparts all over the world. The Luxembourg fund industry took the situation in hand at the onset by setting up a dedicated Alfi Madoff taskforce, composed of industry leaders who worked very hard to communicate updates on a regular basis as well as delivering a mid-term report and a final report as guidance to all of us.
What is important here is that Alfi involved all the players in the fund industry’s value chain in this important endeavour: the asset servicing practitioners, the asset managers, the lawyers, the regulators, etc. As an industry, we all worked together towards a common goal. Gandy: The very basic question was how long did it take an organisation to see whether it had exposure to Madoff. The answer to that question came straight back as ‘No’, because we would not have gone down that route. If we’re running our organisations the way we want them to run, we have our closely controlled network management. If somebody wants an arrangement that’s outside of that, then it is looked at as an altogether different potential risk position. We would need to investigate and undertake due diligence on the suggested parties and arrangements to ensure they meet numerous standards and criteria. But before this, and very importantly, we would question why we would want to support an arrangement outside of our normal practice. So the answer to this question was very easy, and very quickly, ‘No’. Denis: It also provided an opportunity to look at ourselves, particularly to put more emphasis on protecting the investor as well as how we sustain this industry as a whole, the asset servicing side. Alfi now has a dedicated Alfi Investor Forum in place. Aside from the typical agenda of latest product developments and regulatory changes, this year’s Alfi Spring Conference will focus on investor protection and new developments within the infrastructure of this industry. I think this is innovative and very positive in that it responds to the industry’s need to bring forward two of its critical elements: the investor, the driving force behind the fund industry and the infrastructure/service provider, the participant that sustains the funds’ life cycle. Veillet: Madoff was first of all a US scandal that involves fund management and it seems that some people managed to transform that into a Luxembourg depository bank problem. The depository bank is not, and should not be the only safeguard for investors. We have the board of directors, we have the auditors... it’s normal that there is some spotlight on the depository bank but it should not be the only actor to be under the spotlight in this case.
Godefroid: Yes, but the industry regulators are approaching it the other way around, but they’re going for the depo bank. Veillet: Yes, so we need clarification anyway. Gandy: We’re talking about Madoff being used as a sub-custodian. 
It does highlight the need for ‘look through’. Ucits IV is addressing this. In a fund of funds, master feeder environment, you need to be able to look through and make sure there actually are assets in the master or the underlying fund it’s invested into. All fund of hedge funds and funds of funds should have been looked at to question if they are as comfortable as they should be. This is directed to the fund manager, the Sicav board, and also the depository. Funds Europe: Let’s put Madoff aside and move on to talk about more positive developments. Will Luxembourg be successful in attracting fund managers to domicile Chinese QDII funds here? If so will the custody & asset servicing roles be stretched significantly or do processes fundamentally stay the same? Gandy: Things have obviously moved forward, we have the Memorandum of Understanding you referred to. The market there went very quiet during the crisis and there were no allocations from the CSRC to the local domestic custodians. They’ve made some allocations in the last few months and the structure is to invest in well-performing foreign funds. Looking at the current exposure and penetration that Luxembourg funds have in Asia, the region already has a comfort level around such funds, so I would expect that to be the case. The unanswered question at the moment is the volume and when. Denis: BNY Mellon in its commitment to this industry regularly sponsors and takes part in the yearly Alfi and LuxembourgForFinance (LFF) financial road shows, colloquially called ‘economic missions’. The latest one being the LFF Asia Tour last October where we covered Hong Kong, Singapore and Beijing. Asia, specifically Hong Kong, Singapore, Taiwan and Japan, are mature markets for Luxembourg-domiciled funds hence the importance of these economic missions  to update key markets on relevant topics on the Luxembourg financial centre and the investment fund industry. The hot topic of this last Asia tour, particularly in Beijing, focused on QDII schemes. We described QDII schemes in the context of using Luxembourg Ucits for indirect sales to Chinese investors. Luxembourg Ucits are eligible for QDII portfolios and can be promoted by banks, fund managers and securities firms in China. We believe there is a positive trend and huge potential for the future in QDII schemes where Luxembourg, as a fund domicile, can be used by international groups to obtain exposure to the Chinese market. 
Letting Alfi statistics speak for themselves, where most foreign-domiciled funds distributed in Asia are Luxembourg funds, what is also interesting to note here is the increase of Asian asset managers that currently have a Luxembourg-domiciled fund product range. To date, there are 16 Asian asset managers who hold 200 funds with assets under management of approximately US$34bn (€24.8bn). This trend is not set to stop. Most of these AuM are currently serviced by Luxembourg-based administrators, who have fund servicing hubs across various Asian countries, particularly in Hong Kong, Singapore, Taiwan and, most recently, Malaysia.
It should be pointed out that most of us practitioners who have servicing hubs in Asia  also serve domestic products such as QFIIs and QDIIs today. We assist in the structuring and launch of these products and follow with the administration of these, as required. We service these fund types within time zone, local language and support the local operating requirements. Funds Europe: So, since you already service these types of funds, from other locations, would you say it wouldn’t stretch your capabilities much, were they to be domiciled in Luxembourg? Denis: No. For us it is another product type that we are required to serve but let us not forget that it is a new emerging product and we must ensure that we have the optimum administration and servicing capabilities to support these. Bock: And to be able to understand. There are specific needs that are to be understood and I can also confirm I don’t see an extreme difference. I come back to the education. China is very focused on itself, it has a booming market and Asia, as a region, is a booming economy. It’s about fostering a trust [among Chinese investors] that investments outside of Asia can also have some effect. That’s where Luxembourg can bring its brand name in. Hong Kong will also try to attract QDII schemes. It’s also about having a more international approach to distribution and dedicating efforts to making products as attractive abroad as they are in the domestic market. Godefroid: Today the vast majority of foreign funds domiciled in Luxembourg are distributed in Asia. The Asian funds market is still evolving and as yet there is no real Ucits equivalent. As such, asset management companies are using Luxembourg-based Ucits to access Asian markets.
Moreover, as Asian markets open up and invest outside of their region we will see monies return to Ucits funds. Any upward movement in this area is seen as business as usual for a global provider such as Citi. What is important for managers with a global distribution focus is that they have a partner with a direct presence in all regions who can implement their cross-border Ucits distribution strategy while continuing to manage costs and launch new products.
Gandy: Having been to China and discussed with the CSRC and asset management companies, the CSRC has put the responsibility of trustee on the domestic custodian, for which you have to have a domestic custodian licence.
This is a new area for them because they’ve had that responsibility before but only for domestic assets and subsequently they’ve gone into Hong Kong. With QDII, they’re able to go on a much wider basis so they will be looking for funds that they’re comfortable with, that are in a regulated environment. Also from the likes of our organisations they’ll be looking for assistance in how they discharge those responsibilities on a wider basis. So from a Luxembourg point of view, there’s a lot that can be given into that market to assist it in its growth. Denis: China is a very dynamic country and is seen as a new frontier for most global fund groups today. From an investment funds perspective, a lot of communication and education has already happened across numerous financial conferences in China over last three to five years.  The Chinese are quite knowledgeable on investment products; however, there needs to be some hand holding when it comes to the asset servicing aspects of this industry. Luxembourg players can and do play a major role in this knowledge-sharing process today. Gandy: Particularly regarding pricing and things of this nature, which they’ve not had to deal with before, such as global portfolios. Funds Europe: Where do participants stand on the EC’s intention to centrally clear OTC derivatives? Does the location of the CCP matter to Luxembourg? Gandy: Clearly within the EU this is one of the tools, and potentially the major tool, to control OTCs. We’re almost back to where we started in the discussion: what is the exposure? Where are the record keeping and control processes?
Again, the whole focus is going to be around how all of these are recorded. There are one or two processes and systems out there, but it seems there will be regulation introduced this year, it will make it mandatory that if you do not clear through the CCP you’re likely to have to put up more capitalisation behind it, which is again added incentive to drive it down the CCP route.
These have existed before but from the buy side, the access hasn’t been there. From an asset servicer point of view, we will support what our clients want. One of the questions will be ‘geographically, what is the impact?’ The EU has made a very strong case that it must be in Europe for European assets. All of us within the industry will welcome this additional control environment. Godefroid: But isn’t it a sort of a paradigm shift away from the traditional view that derivatives are financial instruments for professional use and thus require only light-handed regulation? The Commission proposes a comprehensive approach that will ultimately enable markets to price risks properly. We cannot afford another situation where the risks of the financial sector are ultimately borne by the taxpayer.
I’m sure the industry will support it. While it is an ambitious and convergent international regulatory outcome it is in line with the objectives agreed at the G20 meeting last September. The expected enhancements in market integrity and oversight will be for the benefit of everyone. Overall, I would expect the legislation surrounding these issues will fundamentally change not just the derivatives market, but will have many spill-over impacts into other parts of our businesses. Veillet: I think the issue goes beyond the CCP for OTC derivatives. We believe the financial crisis gives us a unique opportunity to rethink the market infrastructure in Europe, which has not grown the way the industry wanted it to. It’s still very fragmented, operationally; it’s not as secure or as STP as we would have liked it to be. We believe that we should work on the whole market infrastructure, define what we really want and begin working in that direction.
When we speak about putting a CCP for this, a CCP for that one of the dangers is that we’re going to end up with a market that is even more fragmented with lots of different CCPs. If this happens what about the interoperability between all those CCPs? And the additional risks that it will bring? Bock: It’s a framework and though I’ve nothing against frameworks, it just depends how it’s designed. We have talked a lot about regulation. I don’t think that regulation should control everything, but regulation and Ucits are the proof of test, among others, that by putting a smart framework in place which leaves some flexibility is welcome. Regarding the CCP, for us it’s not really a question of yes or no or where, but it’s the right design. If you have ten CCPs for the same type of product it will probably be a mess. Gandy: What politicians/regulators are looking for is reporting, to see the exposure which wasn’t there before. It’s the transparency. What may happen is that they’ll come out with a regulation, we’ll see a number of them set up and then we’ll see them starting to merge together, in a progressive process. Bock: You just need to make sense of the transparency, because in the end sourcing a lot of information is one thing, but you need to be able to draw certain conclusions from it. Of all of the various challenges we will face as providers or as actors in the asset management space, it’s good to have the expertise to make sense of all the information you are gathering and draw the right conclusions, maybe even anticipate something. This is something that goes across all these topics; what do we make out of all of this? Not just what have we learned?
It’s easy to say, ‘I fell down these stairs and I will never fall down these stairs again’. But you need to learn something more… Veillet: Like, what could be the next staircase we could fall down? Bock: Exactly. Funds Europe: What about your outlook for 2010/2011. What are the issues you think will be critical for Luxembourg?
Gandy: Luxembourg has a very good brand. Ucits itself as a brand needs to get through this regulatory change. We need to make sure we have a proper working model that assigns the responsibility in the right places so that we don’t do anything to damage the Ucits brand. But overall, considering the infrastructure and the way it works, Luxembourg is in a very good position. Godefroid: The increasing importance of global distributor support reflects Luxembourg’s heightened role as a hub for international retail fund distribution. Ucits is still the only truly global fund product, but only by having the full service offering on hand and the right expertise available in Luxembourg and your target region can we continue to make Luxembourg a success in the future and meet future challenges head on. Bock: Also, it’s about Luxembourg being able to position itself as a centre of excellence in exporting the know-how. It’s not just about being present locally but it’s more a knowledge hub and not just an outsourcing hub.
These are exciting times because there are lots of opportunities to prove ourselves as providers, as Luxembourg. Apart from attracting business, I think this is what is key for 2010 and 2011.
Denis: All of us around this table have put in a lot of investment over the last 10 to 15 years, to become a global fund services platform which ideally put Luxembourg on the map as a global fund administration centre of excellence today. This is something for which we can all pat ourselves on the back. But we can never be sitting on our laurels. The fund services industry is a fast moving train in that it has to continuously absorb all the elements that impact not only the global fund industry but financial services as a whole.
For instance, the advent of T2S [Target2-Securities] and the imminent changes to the CSD model will bring great infrastructure changes across Europe and the asset servicing world as a whole. As practitioners, we’ve always managed to be on that train and kept up as best as possible with the developments. That’s not going to change any time soon. 
It’s about time though that the industry recognises that service providers put in a lot of investment, across all operational dimensions – people, organisation, processes and technology – to continuously strive to be at the forefront of the developments of the global fund industry. With infrastructure being a key theme at the Alfi Spring Conference this year, it is indeed an opportunity for us to bring this forward. Veillet: We will see an attitude that will be much more balanced between the asset managers and the service providers. The term service providers will probably find its full meaning now. Denis: As mentioned previously, the service provider is no longer considered just a back office that maintains the administration of a fund but a key partner that support an asset manager’s asset growth strategy, emerging investment products, servicing their investors and global fund distribution framework, anywhere, any time in the world. Veillet: Yes. During the crisis we demonstrated that we were more than just back offices. The crisis brought substance to our claim. For 2010 we think we will continue to see consolidation in the industry among clients and service providers. ©2010 funds europe

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